More Foreign Direct Investment in Retail for India?

Recently, India has seen a heated debate on the entry of foreign direct investment (FDI) in the country’s $400 billion retail market. In November 2011, the government proposed a policy change to open up the country’s multi-brand retail segment -- for retailers such as Wal-Mart and Carrefour. Foreign investors were to be allowed to own up to 51 percent of a multi-brand retailer if they invested at least $100 mn, with half spent on infrastructure development in India. Within weeks of the announcement, the government suspended the decision amid protests from opposition parties and small shopkeepers citing concerns over large scale job losses, especially in the small, unorganized retail sector.

What is FDI?

Foreign direct investment (FDI) refers to the net inflows of foreign investment to acquire a lasting management interest (more than 10 percent of voting stock) in a domestic company. In 1997, the government permitted 100 percent FDI in the wholesale cash and carry trade, in which customers arranged the transport of goods from wholesalers and paid for goods in cash (not credit), on a case-by-case basis.

In 2006, it allowed 51 percent FDI in single-brand retail, such as Nike and L’Oreal. Most recently, the foreign ownership limit for single-brand retailers was raised from 51 percent to 100 percent, paving the way for global companies like IKEA and Starbucks to enter India’s huge market.

What exactly is the proposed policy change?

So, what’s different about the entry of multi-brand retailers such as Wal-Mart and Carrefour? What are the likely gains from their entry? And what are areas of concern?

Lower prices for consumers

First, increased competition can benefit consumers as a result of a better variety of products available at a lower price. Previous studies have found that consumers benefitted from the expansion of large retailers into new geographic markets. Concerns have been expressed that that these gains accrue to the middle classes instead of the poor. However, experience from the US suggests that lower-income households tend to shop at the lower-priced large supercenters. On pricing, Hausman and Leibtag (2007) estimate that consumer gains are equivalent to 25 percent of their food expenditures.

Improved supply chains

Suppliers may also be better off following the entry of a Wal-Mart or a Carrefour, if they could strengthen their market position using their association with the large retailer. Economic studies in the US suggest that suppliers who seek Wal-Mart’s wide market reach may derive some benefits (Bloom and Perry 2001). If the suppliers could form a collaborative relationship with a large retailer, they could potentially benefit from the competitive advantage in marketing shared by the retailer (Corsten and Kumar 2005).

Impact on farmers

Some have argued that producer prices may be depressed due to the monopolistic buying power of foreign supermarkets. There is no guarantee that farmers will receive higher prices, since prices depend on the relative bargaining power of the buyers and the suppliers (Singh 2011).

However, farmers in India may also expect to collaborate and exchange knowledge with foreign retailers to boost demand and get better prices. With foreign investors required to make significant investments in infrastructure development, local farmers can potentially benefit from a higher quality logistics and distribution system. Currently more than 30 percent of fruit and vegetables rot before being sold due to the lack of cold-storage facilities and poor transport infrastructure. By enhancing the supply chain and eliminating the middlemen who buy at wholesale prices, mark up, and then sell to small vendors who further mark up, opening the retail industry would help keep food inflation in check.

Boost in infrastructure

Limited infrastructure is one of the top constraints faced by job-creating businesses in India, (More and Better Jobs in South Asia, The World Bank, 2012). With foreign investors required to contribute to infrastructure development, the entry of large multi-brand retailers could help mitigate some of these constraints.

Impact on jobs

In the recent debate, fears have been raised that the entry of retail giants such as Wal-Mart and Carrefour could harm small local businesses and impact employment. The concern is understandable. India has 12 million shops employing over 40 million people -- the highest shopping density in the world with 11 shops per 1,000 people. Ninety-five percent of these are small shops run by self-employed people. In Southeast Asia, countries had to impose stringent zoning and licensing regulations to restrict growth of supermarkets after small retailers were displaced.

However, a study by Basker (2002) shows an opposite effect on the overall local labor market. The analysis finds that immediately after Wal-Mart’s entry, local retail employment in the US increased significantly. Big retail chains actually hire a lot of people. So, in the short run, there is likely to be a spurt in jobs. Eventually, there's likely to be a redistribution of jobs with some drying up (like that of middlemen) and some new ones sprouting up. Similar concerns were expressed when domestic majors were allowed to invest in retail in India. However, big supermarket chains and small retailers have successfully coexisted due to their unique offerings to the customers. Would FDI in retail be any different?

More need for foreign investment as growth slows

The government has recently revised downward the growth projection for the current fiscal year from 7 to 6.9 percent, amid weak global economic conditions, high interest rates and the inability to push through key reforms. Industrial output growth moderated to 1.8 percent (y/y) December 2011, from 5.9 percent in November, indicating a slowdown of factory production. Analysts and the central bank expect growth to remain sluggish in the next fiscal year.

Indian leaders have reacted to these economic challenges. Finance Minister Pranab Mukherjee flew to the US and addressed the Chicago Council of Global Affairs. Mr. Mukherjee listed the recently approved and soon-to-be-approved policies that aim at attracting more foreign investment, such as allowing foreign individuals to invest directly in the Indian stock market, allowing single-brand retailers like Gap, Starbucks and Ikea to open wholly owned stores, and admitting bigger retailers like Walmart.

Despite political opposition, there seems to be some momentum towards a more open economy, as the government responds to the need for new policies and more foreign investment.

Comments

A great piece of India's analysis! India's new FDI policy in the retail sector and other recent economic reforms, aiming at stabilizing the economy hammered hardly by the global slowdown, to some extent have partially reached its purpose on this stage. Its impact on longer-term economic fundamentals, nonetheless, has been largely ignored by the markets which focus on more near-term issues. Thanks for sharing the insightful views!

Hi Fielding, glad to see your comments. This proposed FDI policy has not yet gone through the political structure, thus still in debate. Given the recent economic slowdown, there might be some more incentives for policy makers to implement some measures to attract more investment in India.
I agree with you that the long term policy impact on the economy is still unclear, which is a very interesting policy and research question!

I'm glad that this post at least recognizes the serious concerns with the potential market power Wal-Mart might assume in the Indian retail sector. Certainly, there are likely to be some gains for rural famers if Wal-Mart indeed can improve infrastructure and logistics. I question, however, whether these investments would be provided as a public goods or simply private supply chain improvements allowing Wal-Mart to increase what is already likely to be lop-sided market power. If, through its investments, Wal-Mart is able to gain substantial bargaining power, those benefits to producers might be offset by declining product prices.
Furthermore, the benefits from efficiency in large, Wal-Mart style retail accrue largely to corporate balance sheets (and through them investors) and consumers who can afford goods. Even if consumer prices fall, benefits are still likely to be unequally distributed. Rural producers and consumers and urban workers could see little net benefits or even net losses, while perhaps only lower-middle-class-and-above consumers gain.
(Also to note: Basker only finds a net gain of 50 jobs per entry. And I wonder whether comparisons to the U.S. market hold at all, given the vast differences in retail ownership and distribution and operating margins of small shopkeepers.)
Let's be clear, those MNCs who press for more open rules in retail FDI are doing so not to benefit India. They do it because they wish to better their profits. I'm not arguing India should be protectionist but it must carefully consider whom these rule changes will ultimately help.

Hi Adam, thanks for your comments! Yes, the benefit from improved infrastructure and logistics will depend on the assumption of some positive spillover effects. Of course we need to bear in mind that Wal-Mart makes the investment for its own profit, but there could be some technology/knowledge spillovers.
Fully agree with your point on barganing power and the share of consumer surplus vs. producer surplus. The distrution is rarely equally distributed, which is not surprising. We are not assuming equal benefits among different socio-economic groups. However, the distributional impact may be important for policy makers to consider.
Again we agree with you on the vast differences btw India and the US. Perhaps you could share with us some insights from your experience.